Is fiscal expansion the key to the recovery?

These really are challenging times in the world of economics and finance; not least of all in this country. Polls in the EU referendum have oscillated dramatically in the last few weeks, which has benefited neither our economy nor the value of the pound. The Eurozone looks to be in significant trouble, the situation in China remains unstable, once-thriving emerging economies such as Brazil are now floundering, and the FTSE 100 has officially tailed off by a dramatic 10 per cent since the General Election last year.

To compound the misery, the Organisation for Economic Cooperation and Development (OECD) has now slashed growth forecasts for the UK in 2016 from 2.1 per cent to just 1.7 per cent – the second such cut in the space of six months. All this at a time where wage growth remains slow, the recovery even slower, and the national deficit stands at more than £40 billion.

Dealing with the deficit

The budget deficit has been the core focus for Chancellor George Osborne since the start of the 2010 parliament, and, as has become the accepted norm in this age of neoliberalism, his method for remedying it has been austerity. Cuts, cuts and more cuts – much to the discontent of sectors of the British public.

So, has he been successful in this endeavour? To a certain extent he has, with the deficit having clambered down by more than 50 per cent from the eye-watering figure of £109 billion in 2010.

The difficulty for Osborne is that there is a whole lot more to managing the economy, and the average person on the street is likely to be more concerned with pounds in their own pocket rather than the health of the UK’s budget. And as sustained recovery from the global financial crisis remains elusive, so the gospel of austerity increasingly comes into question.

The argument for Keynesianism

Not so long ago, the OECD was a proponent of the austere approach to balancing books at fiscal level. However, in a change of tune which mirrors that of the IMF a week ago, Catherine Mann, the OECD’s chief economist, has pointed out that the cycle of low growth has become a self-fulfilling trap. Businesses clearly have less incentive to invest if demand, both at home and abroad, is insufficient, and, coupled with the problems facing the global economy, believes the net result is a series of “negative feedback loops.”

Her proposed solution? Structural reform, and, more importantly, a collectively more expansionary fiscal policy among OECD countries, with investment in infrastructure and public works at the heart of it. To put it simply, the focus should be on spending our way out of low productivity, wage growth and investment into a state of financial health – rather than cutting our way there. It’s a way of balancing the books that would no doubt get a firm nod of approval from John Maynard Keynes.

Further analysis conducted by the organisation suggests that if all the rich OECD countries were to increase Government spending by 0.5 per cent of GDP, world growth would be boosted 0.4 points, with the EU and UK benefiting from a point pick-up to the tune of 0.6. And the kicker which may give Osborne some food for thought is that public debt stock in the UK would fall by 0.3 points.

So, would it actually work?

Certain politicians, economists and sectors of the electorate are in absolutely no doubt that such an approach would pay dividends, and that the increased expenditure at fiscal level would be more than offset by the increase in growth (and therefore tax receipts). The difficulty is that the only way of knowing if such a methodology would work is by actually trying it. And there isn’t much of a clamour for a shakeup among the OECD elite at the moment. In fact, the OECD’s secretary general Ángel Gurría made the observation: “They are talking about it, but they are not doing it.”

The cynic might observe that the only situation which may predicate a change of tack would be if things were to get worse, thus blowing the austerity argument out the water and paving the way for change. There are currently a whole cocktail of threats which could oblige, so perhaps that day isn’t too far away!

Or perhaps, rather than economic disaster, it will just need a brave (and elected) Government to step up to the plate and sell the idea of change.

But they would do so by putting their political lives on the line. Quantitative easing, suppression of interest rates, buying of bonds… these have all been tried and either failed, or loosely maintained the status quo. So is fiscal expansion the missing link which will take us from the state of limbo we currently find ourselves in and towards sustained growth? Or is it a last resort, destined to make things worse?

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Michael Todt

Mike joined Lending Works in early 2015 with a background in marketing and journalism. Having long held a passion for economics, he is now the chief contributor to the Lending Works blog, and regularly writes about all things peer-to-peer lending, fintech and personal finance.